The Business of Living: After being reimbursed only 38 cents to the dollar, Stanford University Medical Center axed much of its HMO business. This year, the center is expected to break even.

Take Your HMO and Shove It

Stanford Medical Center rebounds from brink of financial ruin, but at what price to the community?

By Loren Stein

THE END OF my relationship with Stanford University Medical Center had all the marks of a bad breakup. The form letter from my insurance carrier stated that Stanford would no longer be accepting Blue Shield HMO patients, and that as of the first of this year, I would be effectively terminated. I was history. No goodbyes from my primary-care physician, whom I especially liked and trusted; no apologies or regrets from the hospital. I signed up with Palo Alto Medical Foundation (a good clinic, no doubt) and started from scratch with a new doctor who seemed less than thrilled to be adding another new patient to her practice.

Of course, I wasn't the only jilted customer. Some 50,000 Stanford patients received a similar letter last fall when Stanford Hospital and Clinics summarily pulled the plug on all six of its capitated, or flat fee, HMO contracts. These contracts, a centerpiece of managed care, paid Stanford a fixed monthly fee for members like me to have full access to a hospital's worth of care. These plans keep costs low for members but force hospitals to absorb the medical costs for patients who are sicker than others.

Fortunately, I did not have any scheduled surgeries or require ongoing critical care, so the move to another clinic was not overly traumatic. But this was not the case with other patients, who, burdened with serious or life-threatening illnesses, had to scramble to make sure their medical care was not disrupted. The radical step, taken to save Stanford from financial ruin, sent a shiver through the medical insurance industry about what may lie ahead for other similar HMOs.

"Stanford cannot accept payments below cost. We can't sustain that," says Roy Santerella, chief financial officer for Stanford Hospital and Clinics. "At the time, it sounded good, but the capitation business wasn't viable for us. We were losing money on the terms of every contract. Taking a stand like this was really the right thing to do."

Before exiting the HMO plans, Stanford faced an operating loss of $40 million in the 2000-2001 fiscal year and anticipated losses of $85 million in fiscal 2002. Now, says Santerella, revenue shortfalls have settled at $28 million last year, and he expects the medical center to break even this year.

Stanford officials took other steps to save the medical center from a financial free fall. They closed the outpatient pharmacy, discontinued nonprofit services such as the home care and hospice program (patients were transferred to other agencies) and switched the Coastside Clinic in Half Moon Bay to private practice. They narrowed the number of suppliers and negotiated better pricing; got tough on collecting outstanding receivables; instituted a purchasing review system; and appointed physicians to direct operating rooms to streamline scheduling.

But shedding its capitated contracts was the biggest step. "Renegotiating all of our managed-care contracts [to higher-paying fee-for-service plans] was a big risk for the organization, but it really changed the revenue picture for us," says Santerella. Under its capitated contracts, he says, the hospital was only being reimbursed an average of 38 cents on the dollar.

Targeted Strike

The move, says Santerella, was a targeted strike against insurance carriers--not patients. Six big-league managed-care companies--Blue Cross, Blue Shield, HealthNet, Aetna, Cigna and PacifiCare--were put on notice last April that they had to renegotiate higher reimbursement rates with Stanford or find other health-care providers for their members.

"Insurance companies have to understand that if they want us to be a provider they have to pay for what the care costs--there is no cost subsidization," Santerella says. "One part of the equation can't cannibalize the other part of the equation."

PacifiCare's Cheryl Randolph says that although her company has had a longstanding relationship with Stanford, "we didn't think it was fair to ask employers and members to shoulder a significant cost increase." Some 5,000 PacifiCare HMO members were transferred to five other local medical groups and a PPO (preferred-provider option) contract was negotiated with Stanford that reimburses on a fee-for-service basis.

Blue Cross' headache involved reassigning 10,000 HMO health-plan members to a dozen other medical groups in the area. Some members opted to follow their doctors to other hospitals that were affiliated with Stanford. "We tried to negotiate--we put our best offer on the table--but you can't force a provider to agree or sign a contract," says Michael Chee of Blue Cross of California. "We were told, 'It's a business decision to terminate all capitated contracts.' They made no attempt to negotiate."

Tug of War

Stanford's actions reflect a growing backlash against managed care, say health-care experts. "This is the first time I've seen a major academic health center tell HMOs no thanks and stick to it," says leading health-care analyst Peter Boland of Boland Healthcare in Berkeley.

California hospitals, such as UC-San Diego and Sutter Hospital System, have bailed out of an isolated HMO contract that they considered unreasonable, says Boland. And in April, after approving a huge 25 percent jump in its HMO premiums, CalPERS (California Public Employees' Retirement System) dumped two of its HMO plans (HealthNet and PacifiCare). But he says, he's never seen anything on this scale before.

"A new dynamic is taking place: the balance of power has shifted from health plans to providers over the last two years," Boland says. With skyrocketing health-care costs, employers complain to insurers that they're paying too much for their health plans, while hospitals and medical groups argue that their reimbursements from insurers are too low. Until recently big insurance companies held the upper hand in the struggle over prices charged by hospitals.

"Each has legitimate claims to negotiate with one another as equals for the first time in the marketplace," Boland says. "This tug of war will be an annual event for providers, health plans and payers."

As far as hospitals go, Stanford had a lot of leverage. The only teaching hospital in Santa Clara County (its nearest competitor is UCSF), it's also a regional tertiary-care center serving the most complex medical cases, has a Level One trauma center for treating the seriously injured and remains one of the nation's top medical schools. Its faculty snags more grants per member than any other academic health center in the nation for cutting-edge clinical research on innovative medical treatments and technologies. U.S. News and World Report has rated Stanford as among the Top 10 medical schools and hospitals in the United States for the past five years.

With all this acclaim, why was the medical center hemorrhaging cash? Aside from losing money on its fixed-fee HMO contracts, Stanford was grappling with losses for other reasons. The failed merger of two Stanford hospitals with two USCF hospitals ultimately cost Stanford and UCSF a combined $176 million--although Stanford was heading for losses even before the merger. A 51-day nurses' strike in 2000 cost the hospital $32 million. Lower Medi-Cal reimbursements have hurt, as well as cutbacks in the 1997 Balanced Budget Act, which slashed Medicare payments to academic health centers by $115 billion (Stanford lost $80 million in federal funding over the last four years) and cut funding for graduate medical education.

Prognosis Negative

Stanford and other academic health centers have been especially hard hit by managed care in the last few years and are having a difficult time competing with nonacademic hospitals. As many as one-quarter of the roughly 125 U.S. academic medical centers may merge or declare bankruptcy in the next five years, according to a report by PriceWaterhouseCoopers.

Most of these centers--defined by the Association of Academic Health Centers as containing a medical school, major teaching hospital and at least one other health professional school--are operating in the red. Some have already shut their doors; others are consolidating or joining for-profit or nonprofit chains. Several academic health centers (including UCSF) slashed their workforce by 20 percent. Some have renegotiated better HMO reimbursement rates. Other lifesaving measures include cutting lengths of patient stays, increasing admissions and commercializing technology.

"We're talking about real extreme stress at a number of academic health centers," says Dr. David Blumenthal, director of the Institute of Health Policy at Massachusetts General Hospital and professor of medicine and of health care policy at Harvard Medical School.

California's hospitals are even worse off, with 60 percent of all hospitals in the state losing money. The reason: managed care has been here longer and has spread more widely. With a high percentage of the state's insured in fixed-fee plans, reimbursement for health care is much lower than in other regions, says Jan Emerson of the California HealthCare Association.

But the situation is even more tenuous for academic health centers because their mission is multifaceted--and, as a result, more expensive. "Academic health centers have to be profitable enough to support both teaching and research," says Peter Boland. "Not one of the three legs--patient care, teaching or research--can subsidize the entire thing, so it's a constant juggling act." State-of-the-art technologies and exotic treatments also come with a high price tag.

What's more, teaching hospitals absorb enormous costs as the major provider of specialized medical services to the poor and uninsured. (The reasons are both altruistic and less so: teaching hospitals need a constant flow of patients to train medical students and residents, which maintains their good reputation and secures accreditation.) In 2000, Stanford Medical Center shouldered $25 million in costs for patients who could not pay. (Twenty percent of Californians are uninsured, says Emerson, one of the highest rates in the country.)

Keeping teaching hospitals and academic health centers afloat is critical for the community, says Blumenthal, ticking off the list. They do 30 percent of the medical research in the United States. They train all of the country's medical students and half of its interns and residents. They're a major source of clinical innovation. They have standby capacity for transplants and burn and trauma units. And they take all comers.

"All of us want to go to an academic health center when we get really sick," Blumenthal says. "They have path-breaking stuff--specialists and investigators working on the cutting-edge of knowledge."

But there's a ripple effect through the health-care market when hospitals like Stanford raise their prices, Blumenthal says. The net effect, he says, is people get hurt. "When there are cutbacks in the generosity of coverage, the number of uninsured goes up. When costs rise, everyone pays more for health care, but the less-well-off pay the greatest toll."